Behavioral Finance Archives

Are You Making These Two Critical Investment Mistakes?

It’s no secret: getting an early start on saving and investing is one of the most important things you can do for your future! Putting money into the market when you’re young – even small amounts – gives your investments time to grow and compound over time.

Unfortunately, too many millennials haven’t gotten started yet. A recent survey by Bankrate found that only 26% of Americans under 30 were invested in the stock market, compared to 58% between the ages of 58 and 64. (1)

While the stock market has historically seen positive returns over the long run, it’s not hard to understand why many millennials are wary of it. Millennials under 30 have seen two major market crashes: the tech bubble of the late 1990’s as well as the 2008 economic crisis. Many saw how family members and friends lost years worth of savings and were often financially devastated by what happened.

The result: a deep distrust of Wall Street and a desire to avoid the market altogether.

While it is understandable that millennials are wary about putting their earnings into the market, it’s also unfortunate.

In spite of the two crises of 1990 and 2008, if you had invested in the S&P 500 at the beginning of 1985, and kept that money in until the end of 2014, you would have earned over 25 times what you had initially invested. (2) (3)

Even saving just a small amount each week or month would have made a tremendous difference in your retirement savings.

The Second Mistake

While many millennials make the mistake of investing too little in the market, others make another critical mistake. While they may be making regular contributions, they may not be invested in a wide enough variety of securities.

The youngest generations have grown up with access to the internet, social media, online financial media, and the tools to invest in any publicly traded security that they choose and they feel empowered to make investment decisions on their own, without consulting a professional. They’re also able to trade information with friends and make changes to their portfolio in a matter of seconds using their smartphone or computer.

Because of this, millennials are often invested in individual hot stocks, companies they believe in, or companies that sell products they use and like. This can (and will) work for some investors sometimes as a result of sheer luck and the law of large numbers, but it is not a consistent – or wise – strategy to rely on.

Buying What’s in the News

In 2007 researchers at UC Berkeley and UC Davis published a paper where they showed that individual investors have a tendency to buy stocks that had recently been in the news, or that had share prices that had recently gone up (4). By buying these “hot” stocks, new investors were forced to bid up the price to a higher level than they were before the news story came out. The study showed that, because these investors were buying at an artificially higher price, their portfolios ended up performing poorly as a result of having bought these ‘hot stocks’.

Additionally many millennials choose to engage in “socially responsible” investing, avoiding stocks in companies that sell products they don’t believe in, or that engage in business practices they feel are undesirable, and putting their money in companies that they believe in and feel good about.

Unfortunately, this too can have a negative impact on their returns over the long run. By focusing so narrowly, their portfolios are missing a major piece of the market, which limits their diversification. Additionally social responsible investments can have higher fees than their non-SRI counterparts, because they have the added cost of screening out stocks based on certain criteria.

Along with the added costs, and the decrease in diversification that result in focusing only on SRIs, researchers from Princeton and New York University published a paper in 2009 that showed that ‘sin stocks’ have historically outperformed their non-sin counterparts. (5)

Whether you are choosing to invest your money in a single stock, or several stocks, or you choose to invest in a SRI investment, you are limiting your investment choices, which in turn limits your level of diversification and possibly your returns over the long run.

Bottom line: if you avoid these two critical mistakes by starting to save – and invest – early, and by making sure your portfolio is diversified, you’ll be setting yourself up to watch your money grow over time.

Broad-based investment vehicles with low fees and high levels of diversification, if appropriate to their specific circumstances, is one strategy to help clients toward their goals.

http://www.cnbc.com/id/102602094
http://www.moneychimp.com/features/market_cagr.htm
The S&P 500 index is representative of domestic markets and includes the average performance of 500 widely held common stocks. Individuals cannot invest directly into an index.
http://faculty.haas.berkeley.edu/odean/Papers%20current%20versions/AllThatGlitters_RFS_2008.pdf
http://pages.stern.nyu.edu/~sternfin/mkacperc/public_html/sin.pdf

LFS-1189811-050415

One Secret to Investing: Do Less

We’ve all been tempted. Whether there’s a hot new sector that seems to be on fire, or a classic U.S. company that seems poised for a new burst of life, or, worse, a pundit who keeps warning us not to get caught flat-footed.

It’s human nature to be attracted to the next shiny new thing. My 2-year old son was perfectly happy playing with his trusty push truck, for instance, until he got a shiny red Matchbox car for his birthday and abandoned the – still very serviceable – truck.

It’s also human nature to try to catch winners on the way up and want to abandon the underperformers. But that doesn’t mean it’s always a good idea.

While the market as a whole has done quite well over the last 20 years – the S&P 500 has returned approximately 9.9%, and a diversified portfolio of 60% stocks and 40% bonds would have returned 8.7% [1]– the same can’t be said for the average investor.

During the 10 year period from 2003- 2013, the average investor’s portfolio only returned 2.6% annually, [2] barely a quarter of what the S&P returned, and not much higher than the rate of inflation.

What’s the reason for this underperformance?

By trying to beat the market by chasing performance, by trying to time markets, and by overpaying in fees, investors hurt their returns significantly.

Chasing Returns

When a particular investment is performing well, investors often get excited and invest more, causing the price to continue to climb. As it does, more investors are attracted to its returns – even as the stock becomes more expensive – causing the price to rise even more.

Eventually however the investment will return to its intrinsic value, and fluctuate slightly around that number.

When that happens, the investors who tried to chase performance and bought on the more expensive upswing, will lose money or underperform the market.

Timing the Market

It is not surprising that investors try to time the market. If we were able to predict when markets would top and when they would bottom, we’d all be enjoying extraordinary returns. In reality, however, very few people who try to time the markets actually succeed.

According to Morningstar, market timing costs the average investor 1.5% annually. For a hypothetical portfolio that returned 8.7% annually, a 1.5% additional ‘expense’ ends up eating up over 17% of the investor’s returns.

Warren Buffet once said, “the only value of stock forecasters is to make fortune tellers look good.” Famed investor Peter Lynch said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves”. [3]

If Warren Buffet and Peter Lynch don’t believe in trying to time the market, and studies have shown that strategies that try to time the market have very low success rates, it’s a good sign that you’re probably better off not trying too.

Overpaying Fees

If you are chasing returns, and trying to time the market, chances are you are making more trades than you would with a buy-and-hold strategy. That means you are paying more fees, which also affects your overall rate of return negatively.

A Potential Solution

The smarter approach may be to do less. Investors have historically hurt their returns by over-trading. Looking at your portfolio too often or constantly checking up on how the markets are doing can be detrimental to your finances if you are prone to reacting too impulsively. Rather than trying to time the market, or always buying the next hot stock or asset class, investors tend to have more success by taking a hands off approach.

Yes, his red Matchbox car is shiny and bright. But, as my son grows up, I hope he’ll learn to value the tried and true as well. And smart investors do the same, thinking carefully before they leap into the next big thing, or try to catch the current wave and ride it to the top.

Sometimes doing less is doing more.

It may be helpful to speak with a financial advisor to determine if your current portfolio and your current strategy are appropriate for your individual investment needs.

1) https://www.jpmorganfunds.com/blobcontentheader/202/900/1158474868049_jp-littlebook.pdf (page 65)

2) http://www.forbes.com/sites/advisor/2014/04/24/why-the-average-investors-investment-return-is-so-low/

3) http://www.nytimes.com/2014/01/28/your-money/forget-market-timing-and-stick-to-a-balanced-fund.html?_r=0

LFS-1189812-050415

Financial Planning for Millennials: Overcoming the Fear Factor

What do you think of when you think of Millennials? The media loves to paint Millennials as “adventurous”, “risk takers,” and “thrill seekers.” But, surprisingly, when it comes to financial planning for Millennials, their behavior is anything but risky.

In fact, there is evidence that, while emotions and biases play a large part in Millennials’ investment decisions, fear leads the list of behavioral influences.

We Millennials grew up during the Internet crash and have witnessed one of the most turbulent market cycles in recent U.S. history. With the financial crisis of 2008, and the housing bust leading to a recession, many of us have watched our parents struggle with financial security and worry about whether they’ll ever be able to retire. Many recent grads have experienced unemployment as a result of the crisis, and many are burdened with significant student loan debt. Good times? Not.

These experiences during their impressionable years have led many Millennials to take an emotionally driven approach to Financial Planning for Millennials and to adopt conservative money habits that analysts have compared to the investment behavior of young adults during the Great Depression.

They tend to be wary of investing in equities, for instance, resorting to a behavioral bias that favors peer narratives and unscientific anecdotes – such as stories of retirement-age people whose nest eggs were destroyed by the financial crisis – over careful data analysis.

In May 2013, Wells Fargo released the results of a study surveying more than 1,400 Millennials, that found that Millennials view the stock market, and most investments, as a risk not worth taking. More than half of Millennials are “not very confident” or “not at all confident” about the stock market and many of the Millennials who do consider investing in stocks see the market as a short-term investment. The survey also found that Millennials’ primary concerns were student loan debt and paying their monthly bills.

In fact, Millennials have not only taken on more student loan debt than any previous generation but they continue to struggle in a challenging job market. With many Millennials remaining unemployed or underemployed, and with bills and debt as their top priorities, they have very little disposable income for investing. Many, according to a Pew Research poll released in October 2013, did not even begin thinking about saving or establishing a 401(k) until about five years into their careers.

Additionally, a UBS Wealth Management survey report featured on Bankrate.com found that, more 39% of the Millennials surveyed – more than any other age group – said that cash is their preferred way to invest money that they don’t need for at least ten years. That’s three times the number who chose to invest in the stock market, despite the fact that the S&P 500 has gained 17% over the past year while most cash investment yields remain below 1%.

The Danger of Playing it Safe

The problem with short-term stock investment approaches and dipping in and out of the stock market is that it can work against investors, because short-term investments may be subject to a higher rate of volatility. Instead of looking at the long-term data, which shows that stocks typically outperform other more conservative asset classes over the long run, those young investors are fearful of the short-range volatility, clouding data about the positive potential of long-term investing.

That reluctance to get into the market can be problematic for long-term portfolio growth because, without the returns from stocks, it can be difficult to reach savings and retirement goals.

Bigger is Not Always Better…When Finding a Financial Advisor

With the crash of the big banks and the negative publicity surrounding Wall Street financial firms, Millennials became a generation that looked at financial professionals with mistrust. Instead, they rely more heavily on the Internet, social media, and personal networks for financial advice. Their experience with market volatility and lack of job security has had a significant impact on their attitudes and behaviors toward investing. With very little disposable income after bills and debt payment, Millennials want to feel a sense of security with their investments.

When it comes to working with a financial professional, ‘old school’, traditional banking services are of no interest to them. Bigger is not better in their minds; a smaller, more independent financial planning firm may be able to offer a more hands-on and collaborative approach to investing that Millennials feel more comfortable with.

It’s important to Millennials that they find someone they can trust and who can relate to their concerns and be open to new ideas and methods of investing. Sherman Wealth Management understands that being a part of the investing process is a must in financial planning for Millennials. We fill a role for clients who can no longer relate to, or trust, the large financial institutions that once held a stronghold in the marketplace. The professionals at Sherman Wealth Management provide a personalized plan for investing and help our clients navigate through the difficulty of prioritizing financial obligations.

Remember how it was the overconfidence of the large financial firms and irresponsible investors that brought us the financial crisis in the first place? That Millennial reluctance to let history blindly repeat itself may turn out to be a pretty good thing after all!

Learn more about Financial Planning for Millennials and our Financial Planning services.

Having the Money Conversation

Millennials have a tremendous advantage over their Baby Boomer parents because they are comfortable talking about money. Having grown up with social media and the internet, this generation is not as private as their parents and grandparents are, especially about subjects like money and finance. The advantage is that open conversations can reduce fears and increase understanding, which can result in better decision making.

Yet, with all this comfort in discussing financial matters, many Millennials are hesitant to meet with a financial advisor. It’s one thing to gather information from family and friends or read articles about investing, it’s another to discuss your personal information with a financial advisor. That’s when it moves from theoretical to personal and that can create a great deal of fear and discomfort.

Why Fear Gets the Best of Us

How Much Do You Really Know About Finances? As educated professionals, it’s common to feel like you should know everything. After all, if you don’t understand it, a few internet searches should provide the answers!

When it comes to money matters, though, many Millennials feel like a fish out of water. Internet searches can provide information that’s both confusing and conflicting, and that doesn’t answer individual questions about strategy and direction.

Then there is the question of what information can be trusted. Is the site legitimate and can the writer’s – and site’s – motivation be trusted? While financial information is plentiful, much of it’s either very general or coming from a sales site that promises a secret formula that will turn you into a millionaire.

Financial decisions by nature are very individual and personal. Because there’s no one-size-fits-all investing strategy, personal consultations are invaluable.

Advisor motivations. Can the advisor be trusted? A trusted advisor needs to understand your circumstances, goals, dreams, and aspirations. Once they do, they can help to create a long term strategy that will help to make those dreams a reality. But you must be able to trust that your advisor will make recommendations that are most beneficial to you, the client, not the best for them, the advisor.

Addressing these concerns in an open conversation will go a long way. No one wants to be sold a product. We all want to invest money in a sound strategy. Understanding the reasons for the recommendation will help you understand how it may benefit you and help you pursue your long term goals.

Fear of not being understood. As complicated individuals we want to appear like we have everything in order. In reality, sometimes we’re confident, other times not so much.

Financial advisors have seen nearly every level of financial preparedness. They have seen financial messes and worked with clients to get things corrected. They have seen strong portfolios, weak portfolios, no portfolio, and everything in between.

Even if you don’t feel you have all your ducks in a row, an advisor can help. If you’ve made bad decisions in the past, they can make recommendations for corrective action. If you’ve been unable to get things in order on your own, working with a professional can be the fastest way to get on track.

Markets not doing as expected. This can go two ways. If you invest conservatively and the market takes off you might end up kicking yourself for not being more aggressive. If the markets are slow and you invest aggressively you can end up wishing you’d been more conservative.

When you meet with an advisor, you’re meeting with a professional who understands the investment business and who can make recommendations that are consistent with your financial goals. An advisor does not have a crystal ball; remember that long term investing is not about beating the markets, it’s about making strong financial decisions that over time will lead to increased confidence in financial matters.

Pulling the Trigger

The first step is always the hardest. This is true whether you’re trying to establish a workout routine, learn a new language, start a new job, or change your investing strategy. Resisting change is natural and we are creatures of habit. However, there comes a point when, in order to grow and progress, we have to stop making excuses and get started by meeting with a financial advisor.

Make the appointment. Even if you don’t think you know enough, have enough money to invest, have a good enough paying job, or whatever the excuses for delays have been.

Before you meet with the advisor, write down questions you have. What things have you heard and what things do you want to understand. This can guide the conversation as you begin to develop a relationship with an advisor.

A financial advisor at Sherman Wealth is someone you’ll want to get to know! You’ll want them to know everything about you and your family’s needs. As your advisor learns more about you, they’ll be able to make the appropriate recommendations as opportunities arise.

Learn more about our Financial Advisor services.

5 Things Investors Get Wrong

Humans have a tendency to behave irrationally when it comes to money. Here are the five things investors get wrong that can harm their returns.

Believing They Will Beat the Market

Study after study shows that investors, including professionals, continually under perform the S&P.

In their most recent SPIVA (S&P Indices vs. Active) report, released in September, McGraw Hill Financial found that more than 85% of all funds underperformed the S&P 500, the index found to represent the overall market. (1).

What’s scarier is the fact that individual investors do even worse. In a 20 year study conducted by Dalbar, a financial services research firm, the average investor has seen a return of just 2.1% compared with the S&P’s annualized return of 7.8% (2).

What causes this under performance?

According to Dalbar the biggest reason for this under performance by investors is due to irrational behavioral biases. These include panic selling, under-diversifying, and chasing momentum (3).

Chasing Hot Stocks

In a study done by the University of California Berkley, as well as UC Davis, researchers found that investors are much more likely to purchase shares in companies that have recently been in the news (4), bidding the price of these stocks up.

Additionally many investors make the mistake of trying to chase performance by buying investments that have already risen significantly. A 2011 study by Baird, a wealth management firm, suggests that investors generally chase short-term performance by buying funds that have risen in the short run, and selling those that have performed poorly (5).

The same can be said about the market as a whole where investors tend to purchase stocks after they have seen a large rise, and subsequently sell into weakness (6).

In short, investors sell low, and buy high.

Ignoring Fees

You probably know that fees are important, what you may not realize is just how important they are.

Take for example two 30-year-old investors who each contribute $5,500 annually to their IRAs. They both achieve 9% annualized returns, before fees, over the next 35 years. The only difference between them is that one investor pays annual fees of .5%, while the other investor pays 2.5% in total fees. Over the course of their working career, investor A will have accumulated $1,059,859.21 in their account while investor B will have $682,190.80.

This is a hypothetical illustration only and is not indicative of any particular investment or performance. Return and principal value may fluctuate, so when withdrawn, it may be worth more or less than the original cost. Past performance is no guarantee of future results.

In this example, Investor B’s IRA will be worth less than 65% of Investor’s A account as a result of a 2% difference in fees!

Not Re-balancing

While buy-and-hold is usually a good strategy for most people, it is sometimes necessary for individuals to make slight tweaks to their investments.

This is particularly important if you have had one asset class or investment rise or fall significantly more than the rest of your portfolio. In this case it is a good idea to re balance your portfolio in order to realign it with your target allocation. This ensures that you not only maintain diversity, but also that you buy low, and sell high, by buying assets that have fallen significantly and selling assets that have risen.

Turning to the Wrong People for Advice

Financial advice and information has never been more accessible to the average investor than it is today. Between TV and the Internet, investors are bombarded with information on a daily basis. Unfortunately not all of this information is sound.

Investors should consider carefully the source of any advice they receive, watching out for potential conflicts of interest. Before making any investment decisions you should carefully consider all options, and consider speaking with a financial advisor.

Learn more about our Investment Management services.

Are You Making These Two Critical Investment Mistakes?

The Second Mistake

Buying What’s in the News

One Secret to Investing: Do Less

Chasing Returns

Timing the Market

Overpaying Fees

A Potential Solution

Financial Planning for Millennials: Overcoming the Fear Factor

The Danger of Playing it Safe

Bigger is Not Always Better…When Finding a Financial Advisor

Learn more about Financial Planning for Millennials and our Financial Planning services.

Related Reading:

Having the Money Conversation

Why Fear Gets the Best of Us

Pulling the Trigger

Related Reading:

5 Things Investors Get Wrong

Believing They Will Beat the Market

Chasing Hot Stocks

Ignoring Fees

Not Re-balancing

Turning to the Wrong People for Advice

Related Reading:

INFORMATION

Sign up for Sherman Wealth Snaps